The destruction of pricing power, US Jobs, Draghi, and more

Last Night's Markets
US Jobs
The destruction of pricing power
Draghi hangs a u-ey
That was the year: we’ve had it
Parachuting politicians
Research and Diversions
Facebook Live
Next Week
Last Week

US Jobs

US nonfarm payrolls have produced a big negative surprise in February – only 20,000 jobs, versus 180,000 consensus forecast. The blowout January number of 304,000 was revised up to 311,000, so the cliff that employment has fallen off was even a bit higher.

Analysts are suggesting that the number was “too bad to be true”, that it contradicts all other evidence in the economy and will probably be hugely revised next month. Also a lot of the fall has to do with the extremely cold weather (justifying the quote from Don McLean’s American Pie) – construction payrolls fell 31,000 due to projects being delayed.

And that’s certainly how the markets took it: the US dollar index fell a bit, but not much, while the stockmarket fell more but that was mainly due to the terrible trade news out of China (more on that below).

February employment gnerally in the US was worse than it seems. Hours worked fell 0.3% to 34.4 per week, average, the biggest decline since September 2017, and when you account for the extra 20,000 people that implies an employment contraction equivalent to 350,000 or so jobs.

It all certainly vindicates the Fed’s decision to hit the pause button on interest rates. In an interview, the head of the Federal Reserve Bank of Dallas, Robert Kaplan said: “I don’t believe we should be taking any action at the Fed at least for the first couple of quarters of 2019. I don’t take today’s jobs number as necessarily that indicative, but I do think the economy is slowing.”

As for China, yesterday’s trade data for February was shocking.

Exports fell 20.7%, the biggest fall in three years, amid reports that the trade dispute with the US is not going to end as soon as hoped. The Shanghai Composite share index closed 4.4% lower.

ANZ Research’s Raymond Yueng commented: “Today’s trade figures reinforce our view that China’s trade recession has started to emerge.”

On Tuesday, Chinese Premier Li Keqiang told the annual Parliament get-together that the growth target had been lowered to 6-6.5%, down from last year’s actual of 6.6%, which was already the lowest growth in 28 years.

The way things are going on trade, they’ll be lucky to hit 6% growth, although of course everyone works backwards from the number to keep Beijing happy, so the stats will be massaged to make it seem like China’s economy is growing at 6%, whatever is actually going on.

The thing is that Trump and the US political establishment are trying to get US companies to switch their supply chains away from China to other countries and this is clearly having some effect. Other Asian countries like Vietnam and Philippines are the beneficiaries.

That’s seems to be confirmed by the fact that, in February, Chinese exports to ASEAN countries rose 7% year on year, while to the US they fell 9.9% (in yuan terms). Yueng said: “We understand that one major mobile phone maker has started to produce its goods in Vietnam. We believe the ongoing trade tensions between the US and China have already prompted some corporates to hedge against such risks.”

He goes on: “Looking ahead, we find little reason to expect a rebound in the near term on the back of a sluggish global electronics cycle. As we highlighted in our weekly, Asia’s export figures as well as its inventory-shipment ratio are both pointing to a sobering outlook. The weak external demand will continue to weigh on China’s Q1 growth. This requires a stronger dose of policy stimulus to support growth.”

February sobering all round, which makes the 16% December to February rally in the world MSCI share index look a bit on the unsupported side, although as discussed here previously it was more due to central bank dovishness than actual economic reality.

But with the US and global markets having now had their first negative week for a while, perhaps reality is catching up.

The destruction of pricing power

“There are global factors at work that are holding down the growth of wages, but I’m still optimistic that the laws of supply and demand work. And I say that because if you look at the United States, the United Kingdom and Germany, even Japan now, where the unemployment rates are the lowest in 40 years, wage growth is picking up in all those countries – not rapidly, but it is picking up. Even in Australia there has been a pick up, it would be better if it would be stronger, but… So if you tighten up the labour market sufficiently, wage growth will pick up, and that’s really our hope and our strategy – keep interest rates low, labour market tightens, wage growth picks up, inflation returns to trend, and I think that’s working.” - RBA Governor Philip Lowe in the Q&A after his speech on housing this week.

Sorry about the long quote to start this week, but I thought it was so profoundly stupid, and important, that it had to be repeated in full.

It’s not working, Phil. The market and all economists reckon rates will be cut again this year, maybe twice, so the Guv’nor is about the only person who thinks it is working, apart from other central bankers perhaps.

I mean, for goodness sake, unemployment rates in the US, UK, Germany and Japan are the lowest in 40 years and yet wage growth is picking up “not rapidly”. And look at this chart of Australian unemployment and inflation, via MacroBusiness:

Yes, of course the laws of demand and supply still work in general, but as Lowe says, there are global factors at work, and these factors seem to be well outside the scope of a central banker’s thinking - no doubt, because they are also well outside their ability to influence.

What are those factors? Well, at the risk of stating the obvious, the marginal pricing power of both labour and corporate capital has been destroyed.

It’s obvious because it’s simply what the statistics are saying: that companies and workers are unable to raise their prices much, which is just another way of saying that inflation and wage growth are low. But it’s worth expressing it as a loss of pricing power because that helps lead us towards the correct (in my view) answer to the problem.

Central banks and economists are still labouring under the Milton Friedman dictum that “inflation is always and everywhere a monetary phenomenon”. That is, if you withdraw money from the system prices fall and if you expand it prices will rise.

This is plainly wrong (and it wasn’t the only thing Friedman was wrong about, but that’s another story). Even if it were true, something else has been going on with money that has been countering the massive increase in the volume of it that has been engineered by central banks: its velocity.

It has near enough to halved. The velocity of money is simply the frequency with which it is spent, as opposed to hoarded, and it’s being hoarded partly because with interest rates at close to zero and in Europe less than zero, you might as well hold cash and forget about collecting interest. It’s safer. Also you don’t have to rush out and spend if prices aren’t rising.

But in any case, inflation of the prices of labour, goods and services is not a theoretical monetary idea that exists inside economic textbooks – it is about power in the real world, and who has it.

As always in economics, there’s an “on the other hand” of course: in the Weimar Republic in Germany in the 1920s and Zimbabwe after the late 1990s when Mugabe was printing money to finance his war against the Congo, devastating hyperinflation did result from the increase in the supply of money and the consequent debasement of its value.

That is, inflation CAN be a monetary phenomenon, just not “always and everywhere”. If the value of money is degraded by oversupply, then obviously the amount of it needed to buy a loaf of bread must increase. But this is not what’s happening at the moment, even though the supply of money has been massively increased and the price of it reduced to almost nothing.

What’s happening now is that economic power has shifted from labour and corporates to consumers as a result of globalisation, the internet and automation. It was predicted, and it happened.

It might not seem like it after the banking royal commission and all the atrocities committed against consumers that were exposed, but in a way the existence of the royal commission proves the point. Kenneth Hayne has been, above all, an agent of consumer power. The royal commission was also the last gasp of the financial sector’s power over consumers: they are now pretty much spent forces.

The broad themes at work are familiar to everyone: free trade, hyper-competition and antitrust laws, freer movement of people as well as a mind-boggling and growing refugee problem, the internet and social media increasing consumer knowledge, relentless automation.

Look at this chart of global refugees (it’s a few years old, but the story still applies):

These people are looking for jobs, somewhere other than their own country.

There are currently 1.2 million temporary migrant workers (TMWs) in Australia, mostly getting ripped off and underpaid.

As I drove home the other night there was an interview with a café owner on the radio. He was saying that he can’t make a profit because he pays award wages and other cafes don’t; he said no one paying award wages in hospitality is making a profit.

That same day I had read this article in The Age by someone explaining why they had to give up picking apples: “Conditions on-site were harsh, with no sunscreen or shade provided. There was one Portaloo among the 30-40 contractors which was filthy and had no water for flushing. The foreign workers rented homes nearby, and conditions in them were squalid, with stories of vermin infestations, faulty showers and flooded toilets. A Belgian couple told me their house was in such disrepair that they camped in the backyard.

“Prices set by the company were pitifully low - between 90 cents and $4 for each tree depending on the size - and expectations for the quality of work were unreasonably high. It was impossible for most workers to make a living wage. I worked harder than I’d ever worked in 20 years in the workforce. I made $18 for two hours work. A week before Christmas and a mere month before the birth of my second child, I had no choice but to leave.”

In March 2016, the Senate Education and Employment References Committee, produced this report called “A National Disgrace: The Exploitation of Temporary Work Visa Holders.”

It concluded: “The assumption that Australia is solely a country of permanent settlement is now outdated. Labour mobility is a key feature of globalisation and has led to a dramatic increase in the global migration for work.”

At the same time, union membership has declined dramatically:

Back to the apple picker: the reason fruit pickers are being exploited is because of pressure from the big supermarkets to reduce wholesale prices (and also to produce uniform fruit, in pursuit of which 80% of apples are apparently discarded).

Coles and Woolworths are merely passing on the pressure caused by Aldi, as well as the broader more fundamental pressure from customers who can’t get a wage rise and can’t, or won’t, pay more for their groceries.

Not just groceries: this week no sooner had poor old Myer announced plans to increase profits by stopping discounting and getting prices up, than an over-stocked David Jones launched a whole new round of discounting, offering 20% or $30 off for every $150 spent store-wide.

And then of course there is the constant of Amazon, steadily increasing sales and market share around the world by undercutting the retailers who have to pay rent. Needless to say the temporary migrant workers who are the couriers for online retailers are less demanding than shopping centre landlords.

I could go on (and on), but you know the story. The declining pricing power of labour and companies makes it almost impossible for central bankers to ignite inflation, for the simple reason that they haven’t got hold of the right lever.

There is no lever. Nothing on earth is permanent, especially when it comes to economics and the business cycle, but this is pretty close to it.

Even the mighty US President Donald Canute has been unable to hold back the tide of America’s ballooning trade deficit with tariffs and threats: globalisation is both entrenched and too powerful a force.

So, for that matter, is automation and AI. It’s part of the same story: corporations under pressure to remove costs and improve customer experience are rapidly shifting to using machines to deal with customers instead of human beings.

It was probably started by Facebook’s use of algorithms to edit content and tailor it for readers’ preferences. Human editors like yours truly have been doing this for hundreds of years and are now being replaced by machines that are better and cheaper.

That’s now happening with phone-based customer service, as spelt out in this interview with NAB director and AI start-up founder, Geraldine McBride last month.

And although trade globalisation has been on the wane since the GFC…

… it’s not going to be reversed entirely and nor is the tide of people looking for a better life than the one they were unlucky enough to be born into.

In other words, the pricing power of labour and capital is not going to return in a hurry, which means consumer prices – the measure of inflation – will remain in slow growth.

That means the key levers for achieving economic growth will be asset prices, government deficits and population growth, as they have been for 10 years.

We saw some perfect demonstrations of that this week. On the day the national accounts showed that all Australian growth in the December quarter was provided by government spending, the RBA Governor Philip Lowe complained about the impact of falling house prices on consumption and suggested it was time the banks loosened the credit purse strings.

It was also discovered that we are in a “per capita recession”, that is without population growth GDP would be contracting.

Meanwhile share prices have had a huge January-February despite weak profits, because central banks have engineered a rebound in valuations.

And the US economy has been kept afloat by tax cuts which have increased the budget deficit by 77% (!) this year to US$310 billion. And that’s just the beginning since the Republican tax cut package will cost US$1.5 trillion over ten years.

Then there’s this week’s U-turn by the European Central Bank…

Draghi hangs a u-ey

To drive the above point home, here’s a quote from Thursday night’s press release by ECB president Mario Draghi:

The Governing Council now expects the key ECB interest rates to remain at their present levels at leastthrough the end of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

Wow. They’ve even given up on 2% inflation.

Keeping rates on hold was no surprise. The big change in Thursday’s ECB action was the revival of crisis-era cheap loans to Eurozone banks, which the Financial Times described as “abruptly changing course”.

Far from lifting markets, it spooked them: European bank shares all tumbled between 4% and 5% and the euro dropped sharply against the US dollar.

This now ensures that the Federal Reserve is also on extended hold, for at least the rest of this year. That’s because the Fed can’t afford a significant appreciation of the US dollar, which is what will happen if it tightened while the ECB was hitting the panic button.

A big rise in the dollar would kill off any inflationary impulses in the US. In his negotiations with China, Trump is trying to get the dollar down; if the central bank was responsible for a big rise in the currency instead, then its independence would be under threat.

The message for investors is that monetary policy will support sharemarkets for at least the rest of this year, possibly much longer if my thesis about pricing power is correct.

That was the year: we’ve had it

Having said that about monetary policy supporting sharemarkets, that doesn’t mean we’re in for a roaring bull market for the rest of 2019.

It’s always possible of course, but I suspect that we’ve already had it. Thanks to a 14% rally that has taken the ASX200 to within 0.5% of the august 2018 peak, the market PE ratio has gone from 13.5 times to 15.2 times – that is, back to well above average.

Source: Shaw and Partners

That doesn’t mean it can’t go higher (see 2014 and 2016), but there is unlikely to be any support from earnings or the macro economy for the rest of the year, so not so likely this time.

Shaw’s Martin Crabb is projecting dividend yield of 4.77% and capital growth of 2.39% - total shareholder return of 7.16% (“sell”, he says). I don’t say sell, that’s for sure, but I do say don’t expect from the market as a whole much from here. It’s now all about the stocks you pick.

On the subject of earnings, it was a soft reporting season in which “misses” topped “beats” by 30%, and guidance downgrades for 2019 beat upgrades, 41% to 36%:

For the financial year 2019 consensus analyst forecasts are down to 3.3% and 12 month forward forecasts have dropped from 8% a year ago to 4.2% now:

As for the macro environment, this chart from Philip Lowe’s speech on Wednesday sums up the problem:

Household consumption has been supported by a decline in the saving rate, which has, in turn, been allowed to fall because of the boom in house prices. The boom is well over and the saving rate is beginning to rise again. Maybe disposable income will rise to fill the gap, but there’s no sign of that yet.

Globally, growth is tipping over after a flat 2018, at least in part because of Trump’s attack on trade:

The good news is that central banks are on the job and are entirely focused on asset prices, specifically sharemarkets, and will do whatever it takes. Mario Draghi didn’t repeat that momentous phrase on Thursday, but he might as well have. As I wrote here a couple of weeks ago, the market is watching the Fed (and ACB, RBA, BoJ etc), and the Fed is watching the markets. It’s an echo chamber.

Or as former Fed chair Ben Bernanke put it in 2002: ““Regarding the Great Depression, you’re right. We did it. We’re very sorry...we won’t do it again.”

Parachuting politicians

You might be wondering why so many cabinet ministers have been strapping on the parachute and jumping out of the plane before the election.

Well, everyone’s circumstances are slightly different, but as a general rule long-serving pollies are entitled to a defined benefit pension that depends on their final salary.

On average, ministers are on $350,209 annually. The base salary for a back-benchers is $199,040. You would rather have your pension calculated on your ministerial salary than the one you’re likely to be on after the election. Just saying.

Research and Diversions

Research

Brookings Institution has published a “forensic examination of China’s national accounts”. “Relative to the official numbers, we estimate that GDP growth from 2008-2016 is 1.7 percentage points lower and the investment and savings rate in 2016 is 7 percentage points lower….local statistical bureaus are susceptible to pressure by local officials who may have an incentive to report inaccurate statistics.”

Shane Oliver: seven reasons why dividends are cool.

In the past, “When the planet got hot, it got really hot. Ancient warming episodes … were always far more extreme than theoretical models of the climate suggest they should have been. Why? The answer seems to be clouds. …as the Earth warms, clouds become scarcer. With fewer white surfaces reflecting sunlight back to space, the Earth gets even warmer, leading to more cloud loss. This feedback loop causes warming to spiral out of control.”

Concrete: the most destructive thing on earth. “All the plastic produced over the past 60 years amounts to 8bn tonnes. The cement industry pumps out more than that every two years. 

The “Green New Deal” proposed by Alexandria Ocasio-Cortez has been a loose set of goals rather than a clear and defined set of policies – up to now. Last week, she and Senator Ed Markey released a framework that sets out some of the more concrete proposals. Here it is. I suspect it’s going to be worth knowing about.

The inside story of Michael Cohen’s testimony. “Cathartic musings on a legal pad, a trip to the basement, and a eureka moment all led Cohen, Trump’s disgraced former lawyer, to a moment of public triumph.”

Behind Alexandria Ocasio-Cortez's interrogation of Michael Cohen. This is very interesting.

Trump, Kim, Cohen and the limits of the President’s power.

“Trump promised to shrink the trade deficit. Instead, it exploded.”

The curious case of Jared Kushner’s security clearance (this is going to become a big deal, I suspect).

How the web was lost. The internet was shaped by utopian-minded intellectuals who valued respect and transparency. So how did we end up with the internet of today?

Facebook is secretly working on a crypto coin. “The Facebook project is far enough along that the social networking giant has held conversations with cryptocurrency exchanges about selling the Facebook coin to consumers, said four people briefed on the negotiations.”

What we know about Facebook’s secret crypto currency, and what we don’t.

America’s cold war with Chinese tech turns hot. “The world’s two most powerful countries are fighting over the most important next-generation communications technology.”

Alibaba is investing huge sums in AI research and resources?—?and it is building tools to challenge Google and Amazon

Why the war for Kashmir burns on: “...the main impediment to a final peace has always been the Pakistani military. Not only have Pakistan’s generals fuelled the insurgency, and sheltered and abetted terrorist groups such as Jaish-e-Mohammed and Lashkar-e-Taiba, but, by smothering Pakistani democracy, they have also made reconciliation between the two countries all but impossible.” 

The astronomical cost of clear air in Bangkok.

BMW has unveiled an ultrafast charging station for electric vehicles – 3 minutes for 100 kilometres of range.

Carpocalypse: The founders of the ride-sharing app Lyft filed their IPO papers last week, and their vision for the company is dramatic. Lyft (which works a bit like Uber) is not just about getting you from A to B, they say. Rather, founders Logan Green and John Zimmer believe that car ownership is in permanent decline and they want to help it die, they write in their S-1 filing.

The gilets jaunes are more than a protest. This is a modern-day jacquerie, an emotional wildfire stoked in the provinces and directed against Paris and, most of all, the elite. French history since 1789 can be seen as a sequence of anti-elite movements, yet the gilets jaunes have no real precedent. 

Here’s why Trump will never win over Kim Jong-un: “Trump has nothing sufficiently attractive to offer Kim. Giving up precious nukes in exchange for a removal of the sanctions seems to him a rather poor deal; their symbolic value is profound. The last thing he wants is a Trump-style economic miracle bringing condos – and all that follows – to the banks of the Taedong River.”

Lab-grown meat: Motif Ingredients announced that it had raised $90m in funding, the largest Series A round ever for a food technology company. This makes Motif the largest company focused on cellular agriculture – the new industry creating animal products without animal farming.

The making of the Fox News White House. “It’s the closest we’ve come to having state TV.”

The Aldi effect: “how one discount supermarket transformed the way Britain shops.”While the major supermarkets dozed, convinced that many people would not be seen dead in a discount store, the German chains quietly turned the sector on its head. Nearly two-thirds of households now visit an Aldi or Lidl branch at least once every 12 weeks.”

Peak car: “Rather than signaling the end of the road for the automobile, peak car is a reflection that reurbanization [sic] and the widespread adoption of mobile apps that can summon a vehicle on demand will lessen the need for many of the 1.3 billion vehicles now on the road.

Uber, Lyft, Airbnb and Pinterest plan to go public. California’s newly minted rich will be hungry for parties, houses, boats, bikes — and ice sculptures.

Diversions

The attack on the “constitution of knowledge” (yes, led by Donald Trump). “If trolling is sociopathic and disinformation is parasitic, how did this ancient but usually containable bug become a super-virus?”

Robert Manne, on Kevin Rudd’s 300,000-word (!!) memoir, “The PM Years”. “I am writing because I believe Rudd has mounted a formidable argument that ought to be answered and not simply ignored. Just as being fashionable is not the same as being right, so being unfashionable is not the same as being wrong.”

The secret lives of Facebook moderators. “The panic attacks started after Chloe watched a man die. She spent the past three and a half weeks in training, trying to harden herself against the daily onslaught of disturbing posts: the hate speech, the violent attacks, the graphic pornography. In a few more days, she will become a full-time Facebook content moderator, or what the company she works for, a professional services vendor named Cognizant, opaquely calls a “process executive.”

Mark Zuckerberg’s horrible people skills are ruining Facebook.

The Secrets of the World's Greatest Art Thief: Stéphane Breitwieser robbed nearly 200 museums, amassed a collection of treasures worth more than $1.4 billion, and became perhaps the most prolific art thief in history. 

The Onion: Mueller investigation nearly done with first day of Trump campaign.

The Invisibility of Older Women. “As they age, women experience less public scrutiny—and entertain a wider set of choices about when and how they are seen.” And older men, I would argue, but not as much as women.

I am not a robot. You know that little Google-powered check-box which says, “I am not a robot”? How does it tell lying robots from truthful humans? How complicated can a little box be? More than you can begin to imagine.

“Why I lasted five weeks in the apple industry.”

The beast within. Humans differ from the generality of animals in their capacity to manage and direct their aggression. “At some point after the evolutionary split from the non-human ape lineage – probably around 300,000 years ago – our male ancestors began to do what the chimpanzees could not: plot together to execute aggressive males in their own social groups….it helped humans outpace neanderthals. Humans became dogs, while neanderthals remained wolves.”

On March 1, a century and a half ago, Russian chemist Dmitri Mendeleev created the periodic table of the elements, revolutionizing chemistry.

How to criticise with Kindness: Philosopher Daniel Dennett on the Four Steps to Arguing Intelligently.

Serotonin is a neurotransmitter that can influence many things throughout your body like your mood, memory, sleep cycle, and even your sex drive. By increasing the serotonin in your body naturally, you can also enhance your mental state and your motivation. Here are 11 natural ways to boost your serotonin. 

Why artificial intelligence is a threat to democracy: “The problem is our technology has become more and more sophisticated, but our thinking on what is free speech and what does a free market economy look like has not become as sophisticated.”

Happy Birthday Maurice Ravel, born March 7, 1875. He’s most famous, justly, for Bolero, the 15-minute orchestral piece that builds, and builds.

And happy birthday Neneh Cherry, 55 tomorrow. One of my favourite pop songs is the one she did with Youssou n’Dour: 7 Seconds. I must say, the rest of her stuff is pretty dreadful – she’s a rapper! Good lord.

This is so good:

Facebook Live

If you missed #AskAlan on our Facebook group this week (or if you don’t have access to Facebook) you can catch up here. And there's also the Facebook Livestream page where you can also opt to just listen to the questions and answers.

If you’re not on Facebook and would like to #AskAlan a question, please email it to askalan@investsmart.com.au (new email!) then keep an eye out for the Facebook Live video in next week’s Overview.

Next Week

By Craig James, Chief Economist, CommSec.

Australia: Slowdown in key events

• A quieter week lies ahead in terms of the release of new economic data in Australia.
• The week kicks off on Tuesday when National Australia Bank releases its February business survey. In January the business conditions index rose from a four-year low of 2.6 points to 6.6 points (long-term average 5.8 points). And the business confidence index rose from 2.7 points to 3.6 points in January, below the long-term average of 6.0 points. But rolling annual averages for both business conditions and confidence were above long-term averages.
• Also on Tuesday, the Australian Bureau of Statistics (ABS) releases its publication “Lending to households and businesses”. In December, lending commitments to households fell by 4.4 per cent. But more positively, data showed that the share of first home buyers eased only modestly from a 6-year high of 27 per cent in November to 26.5 per cent in December.
• On Tuesday, the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan. Sentiment has been fluky from week-to-week but the index is still above longer-term averages.
• Also on Tuesday the Reserve Bank Deputy Governor Guy Debelle delivers a talk: “Climate Change & the Economy” at a Public Forum hosted by the Centre for Policy Development in Sydney.
• On Wednesday Westpac and the Melbourne Institute release the March monthly consumer confidence report. The monthly consumer sentiment data is more of a check on the more frequent weekly series. But the monthly report will be of interest this month as it contains the latest quarterly views of households on the wisest place to put new savings.
• On Thursday, the ABS issues a longer-term report: “Household and Family Projections, Australia, 2016 to 2041.” The report is of interest for governments and businesses for planning purposes.
• On Friday the ABS issues the January report: “Overseas Arrivals and Departures”. While there is much interest in the tourism arrivals and departures data, the report also contains figures on overseas migration.
• Tourist arrivals rose by 0.6 per cent to 782,700 in December. Arrivals rose 4.9 per cent over the year. Tourist departures rose by 1.2 per cent in December to be up 8.0 per cent over the year – the strongest annual growth rate in 19 months.
• And in terms of migration flows, net permanent and long-term arrivals stood at 291,250 in the year to December – a fresh 4½-year high.

Overseas: US and Chinese ‘top-shelf’ indicators

• A bevy of ‘top-shelf’ indicators are due in the US and China in the coming week.
• The week begins on Monday in the US when the retail sales data for January is released. The December figures came as something of a shock, with sales down 1.2 per cent, although after rising 1.1 per cent in the two previous months. Economists tip a 0.1 per cent lift in January sales.
• On Tuesday in the US, the February data on consumer prices is released with the NFIB business optimism index and weekly chain store sales. Economists estimate that the core measure (excludes food and energy) rose by 0.2 per cent with the annual rate dropping from 2.2 per cent to 2.1 per cent.
• On Wednesday in the US, the equivalent inflation data for business (producer prices) is released with durable goods orders, construction spending and the weekly measure of mortgage finance. Economists estimate that the core measure (excludes food and energy) rose by 0.2 per cent with the annual rate steady at 2.6 per cent.
• And durable goods orders (a measure of business investment) are estimated to have fallen 0.7 per cent in January.
• On Thursday in the US, data on export and import prices are released with new home sales data and the weekly figures on new claims for unemployment insurance.
• On Friday in the US the February data on industrial production is released with the Empire State manufacturing index, consumer sentiment, JOLTS job openings and capital flows. Economists tip a 0.1 per cent lift in production after a 0.6 per cent fall in January.
• In China, foreign direct investment data is issued on Tuesday with vehicle sales figures on Wednesday.
• On Thursday in China the January and February readings on economic activity – retail sales, production and investment – are released. Given the variable timing of Lunar New Year, January and February data need to be read together. Money supply and lending data are also scheduled for Thursday.
• And on Friday in China, data on house prices is released – the February reading was up 10 per cent on the year.

Last Week

By Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital.

Investment markets and key developments over the past week

• US, Eurozone, Japanese and Chinese shares fell over the last week on worries about global growth, but Australian shares pushed slightly higher on increasing expectations for rate cuts offsetting, for now, the negative impact of slowing growth. Bond yields fell as the ECB announced more monetary easing. Commodity prices were mixed with metals down but oil and iron ore up. The $A fell on increasing expectations for RBA rate cuts and as the $US rose.
• There were three positives on the global policy/geopolitics front over the last week. First, reports indicate that the US and China are close to a trade deal and that President Trump is keen to announce a win on this ahead of his 2020 election campaign. Second, China’s National People’s Congress saw more policy stimulus announced (including a cut to the Value Added Tax rate equal to around 0.6% of GDP) with the growth target set at 6-6.5% for this year which is in line with market expectations. Finally, as widely expected the European Central Bank announced another round of cheap bank funding (which is a form of quantitative easing) and further pushed out its commitment to keep interest rates down. A settling of trade issues and a shift to policy stimulus (or at least more dovishness in the case of the Fed) is consistent with our view that global growth will improve into the second half this year and the combination of stronger growth supporting profits and still easy monetary policy will likely make this a good year for shares. The trouble in the short term though is that share markets have run hard from their December lows and, with global economic data still weak right now, they are vulnerable to a short term pull pack.
• Doom and gloom on the Australian economy has gone into overdrive. Talk of recession is rife. Economists are falling over themselves in predicting rate cuts. My dog is as excited (if that’s the right word) about an impending recession as she was about Bitcoin 18 months ago! Maybe it’s the curse of The Economist magazine’s cover from last October. But there are five things you need to know about the Aussie economy.

• First, economic growth has definitely slowed further and is likely to remain weak going forward as the housing downturn continues, dragging on construction activity and consumer spending.
• Second, while we have gone into a “per capita recession” with two quarters of growth running below population growth, these have occurred occasionally before with the last one in 2006 in the midst of the mining boom! In fact, as Peter Switzer reminded me, prior to last week I had never heard of the term so there is a danger in reading too much into it just as many did a few years back with the obsession about an “income recession”. 
• Third, a conventional recession remains unlikely given that the mining investment slump is near its bottom, non-mining investment is looking healthier, infrastructure investment is strong, global and specifically Chinese growth is likely to pick up later this year, the April budget is likely to see tax cuts/fiscal stimulus and the RBA can cut interest rates.
• Fourth, but while a conventional recession is unlikely, growth is likely to be well below what the RBA is expecting, and this will drive higher unemployment and lower for longer wages growth and inflation, the anticipation of which will drive the RBA to cut interest rates at least twice this year.  We had thought that this would not occur till August, and after the budget and election were out of the way so the Bank could get a chance to assess any fiscal stimulus but the run of weak data is increasing the risk that the first cut will be sooner. Maybe even on budget day next month to get it out of the way before the election campaign! Waiting for unemployment to rise runs the risk of being too late!
• Finally, its worth noting that the east coast drought is continuing with the Southern Oscillation Index indicating a minor El Nino. Over the last year the drag on growth has only been around 0.15 percentage points, but it could increase the longer the drought continues.

Source: ABS, Bureau of Meteorology, AMP Capital

• A rising risk facing the RBA is that the 2-3% inflation target will lose credibility. For several years now the RBA has been forecasting inflation to move back towards the mid-point of the target range. But as can be seen in the next chart these expectations have proven way too optimistic (and this has been the case for many forecasters, not just the RBA!). The danger is that the longer inflation remains below target the more it will be expected to remain down and the harder it will be to get it up as the experience in Japan and Europe demonstrates. All of which is an argument for the RBA to cut rates sooner rather than later.

Source: ABS, RBA

Major global economic events and implications

• US data was mostly strong. The trade deficit widened in December and construction spending fell but against this the non-manufacturing conditions ISM rose very strongly, new home sales rose for the second month in a row and jobs growth looks to remain solid.
• The European Central Bank has finally accepted reality and revised down its growth and inflation forecasts and announced another round of cheap bank funding conditional on lending to the private sector (what they call TLTRO) and pushed out its commitment to not raise rates out to the end of the year in response. Quite clearly it ended quantitative easing too early and is now seeking to correct the mistake. This is a move in the right direction and adds to confidence that Eurozone growth will stabilize and improve this year. That said the ECB may still have to do more as it not clear that it’s new round of TLTROs is aggressive enough.
• Japanese data showed a stronger than first reported recovery in December quarter GDP and better consumer spending.

Australian economic events and implications

• Australian data released over the last week was decidedly soft. December quarter GDP growth was just 0.2% quarter on quarter with broad based weakness (apart from government demand) and ongoing signs that the housing downturn is impacting consumer spending and this followed similarly weak growth in the September quarter. What’s more, building approvals and retail sales remained weak in January, service sector conditions PMIs remained very weak in February and ANZ job ads fell further in February suggesting that weak growth will soon show up in slowing jobs growth and rising unemployment. On top of this the Melbourne Institute’s Inflation Gauge showed continuing below target inflation in February. It wasn’t all bad though with another spike in the trade surplus in January - although mainly due to gold exports it nevertheless highlights the strength in export prices and holds out the possibility that net exports will contribute to growth this quarter. Overall though it adds to the argument for the RBA to cut rates sooner rather than later.

What to watch over the next week?

• In the US, expect a modest bounce back in January retail sales (Monday) after their December slump, February core inflation (Tuesday) to fall slightly to 2.1% year on year, durable goods orders (Wednesday) to show a modest gain and industrial production (Friday) to bounce back for February.
• In the UK, it will be back to another round of parliamentary votes on Brexit on Tuesday on: May’s Brexit deal; a No Deal Brexit; a delay to March 29 Brexit date; and also on whether to have a second referendum. At this stage, parliament probably won’t support the Brexit deal (although its close), it will reject a No Deal Brexit and vote for a delay, but a new referendum likely won’t get up (just yet). We remain of the view that the final outcome will be either some sort of soft Brexit (as there is no majority in parliament for a No Deal or hard Brexit) or another referendum which turns into Bremain. 
• The Bank of Japan is not expected to make any change to its ultra-easy monetary policy on Friday with indicators regarding growth and inflation remaining soft.
• Chinese economic activity data for January and February (Thursday) are likely to show some further slowing in industrial production (to 5.7% yoy) and retail sales to 8.5%) but a slight acceleration in fixed asset investment (to 6%). Chinese growth may slow a bit further in the current quarter but with stimulus measures it’s likely to pick up into the second half.
• In Australia expect to see a bounce in housing finance (Tuesday) but weaker readings for business confidence (also Tuesday) and consumer confidence (Wednesday).

Outlook for investment markets   

• Shares are likely to see volatility remain high with a high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China, Europe and Australia and the Fed pausing.
• Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
• Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
• National capital city house prices are expected to fall another 5-10% into 2020 led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.
• Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
• The $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.